Cyprus seeks bailout, following Spain. Who's next?

Cyrpus became the fifth country to seek financial aid Monday, as Cyprus banks suffered heavy losses on Greek debt.

By
Menelaos Hadjicostis, Associated Press /
June 26, 2012

Cypriot President Demetris Christofias and Maltese Prime Minister Lawrence Gonzi (R) take part in a joint news conference at the prime minister's office at Auberge de Castille in Valletta ealier this month. Cyprus became the fifth eurozone nation to request a financial bailout Monday, June 25, 2012.

Cyprus on Monday became the fifth eurozone country to request financial aid from its partners in the troubled European currency union as it struggles to shore up its banks, which took heavy losses on Greek debt.

The island nation's government said in a terse statement that it required assistance following "negative spillover effects through its financial sector, due to its large exposure in the Greek economy."

Government spokesman Stefanos Stefanou wouldn't say how much Cyprus would ask for from the European bailout fund, saying the amount will be subject to negotiations in the coming days. The 27 leaders of the European Union are meeting in Brussels on Thursday and Friday.

Analysts estimate the sum would likely be around €5 billion ($6.2 billion) but could go as high as €10 billion ($12.5 billion) That's a fraction of the bailouts given to the other EU countries — Spain has asked for as much as €100 billion ($125 billion)for its banks.

Cyprus, an island in the eastern Mediterranean of about a million people, joined the European Union in 2004 and began using the euro four years later.

Cyprus needs about €1.8 billion ($2.3 billion) — about 10 percent of its gross domestic product — by a June 30 deadline to recapitalize its second largest lender, Cyprus Popular Bank. The bank is the most heavily exposed of the country's banks to Greek government debt, which lost most of its value this year in a massive write-down.

Over the past weeks it has become clear that Cyprus Popular Bank would not find the money from the private sector and would need to get it from the government — but the government itself is strapped for cash and has been unable to raise money in bond markets, where its borrowing rates are too high. The government has been getting by lately on a loan from Russia, but that will run out by the end of the year.

Stefanou said despite its request for European aid, the Cypriot government would continue negotiations for another possible loan from a country outside the EU, such as Russia or China.

Finance Minister Vassos Shiarly said last week that clinching a loan from another country would strengthen Cyprus' bargaining position with its 16 eurozone partners in negotiating the bailout deal. The Cypriot government has been apprehensive about turning solely to the EU bailout fund because it has seen the tough spending cuts and tax increases that Greece has been forced to enact in exchange for bailout money.

The Cypriot economy has thrived on foreign businesses setting up shop due to its low 10 percent corporate tax rate, which the government is keen to protect.

Greece, Ireland and Portugal, which have needed European bailouts to finance their government debt, are on strict austerity plans. Spain, which has asked for money to rescue its banks, is still negotiating the terms of its aid deal.

There's a good chance the Cyprus government may not be able to fend off tough, EU-imposed austerity terms. A recent European Commission report said the island is "experiencing very serious macroeconomic imbalances that need to be urgently addressed" and it proposed slashing spending on the island's bloated public sector and making pension reforms.

"Given the current state of the Cypriot economy, turning to the EU for a bailout was the only option," said financial analyst Michalis Florentiades. "But even if the Cypriot government does secure a bilateral loan, it's uncertain whether this would soften the terms that come with the EU bailout."

Earlier Monday, Fitch became the third ratings agency to downgrade Cyprus' credit rating to junk status, estimating that the island will need another €4 billion ($5 billion) to recapitalize its banking sector. It cited the banks' exposure to Greek debt as well as a rise in bad loans over the last year as the Cypriot economy has shrunk while unemployment has hit a record high of 10 percent.

Fitch predicts that Cyprus' government debt will shoot above 100 percent of its GDP, more than 12 points more than its previous estimate. The agency also expected the government to miss its goal of bringing the budget deficit below 3 percent of GDP through another round of spending cuts and tax increases by as much as a percentage point.

Cypriot banks could suffer further losses if Greece decides it must leave the 17-nation eurozone, since they also hold an estimated €22 billion ($27.5 billion) in Greek business and household loans.

Compounding the island's banking troubles are projections that its economy will shrink by 1 percent of GDP this year.

Cyprus was split in 1974 when Turkey invaded after a coup by supporters of union with Greece. Only it's southern, internationally recognized Greek-speaking part enjoys EU membership. A breakaway Turkish Cypriot state in the north of the island is recognized only by Turkey, which maintains 35,000 troops there.